Friday, 13 November 2015

On Tuesday, two days after the Bharatiya
Janata Party’s (BJP’s) electoral drubbing in Bihar, and two days before Prime
Minister Narendra Modi left on an official visit to the United Kingdom, the
government announced foreign direct investment (FDI) reforms in 15 major
sectors of the economy.

In the defence sector, foreign investment had
been raised by the National Democratic Alliance in its first budget, in July
2014, from 26 per cent (prevailing since 2001) to 49 per cent, with the
approval of the Foreign Investment Promotion Board (FIPB), on a case-by-case
basis. Now 49 per cent FDI will be permitted automatically.

Foreign investment above 49 per cent thus
far required sanction from the Cabinet Committee on Security (CCS). Now
sanction can be accorded by the FIPB.

The other change concerns permissible
levels of portfolio investment and investment by foreign venture capital
investors (FVCIs). Previously restricted to 24 per cent, FII and FVCI
investment will now be permitted, under the automatic route, to 49 per cent.

So far, the FDI policy had mandated that
proposals involving a total foreign equity inflow up to Rs 3,000 crore could be
considered by the FIPB, while proposals above Rs 3,000 crore would require consideration
by the Cabinet Committee on Economic Affairs (CCEA). Now, “to achieve faster
approvals on most of the proposals”, the FIPB will consider proposals up to Rs 5,000
crore.

Broadly, FDI liberalisation measures have
been welcomed by industry. Ficci chief, Jyotsna Suri, said “Simplification of
procedures for foreign investments, putting more sectors on the automatic route,
introducing fungibility between FDI and FII and having a single reference
document for all FDI related guidelines are steps that would boost investor
confidence further.”

Yet, most large Indian defence companies
that Business Standard contacted dismiss these changes as largely cosmetic. Top
CEOs point out that FDI has so far been restricted to a mere Rs 30-40 crore (with
Rs 500 crore in the clearance pipeline) less because of FDI caps, than because
of an unviable business model created by the defence ministry’s Department of
Defence Production (DDP).

Potential overseas investors, especially
those with offset obligations, are provided little assurance of continuing
orders from India’s military. For example, Company X, which must produce Rs 300
crore worth of aero parts in India as offsets in a Rs 1,000 crore purchase of
transport aircraft by the Indian Air Force (IAF) would look for assured
long-term orders before sinking FDI into a production unit in India.

“Since the DDP provides no assurances, overseas
vendors prefer to discharge their offset obligations through manufacturing in
Indian facilities, without investing in production units. A more attractive
business case is essential for attracting FDI,” says Jayant Patil, Larsen & Toubro’s defence business chief.

“Furthermore, defence is a strategic field
that is not governed by the rules of normal commerce. Raising FDI caps is no
guarantee that foreign investment will flow in. Overseas vendors might want to
‘Make in India’, but their governments may not give sanction, since most
governments control defence technology”, points out Patil.

Global vendors, however, have long argued
for a “strategic stake”, i.e. at least 51 per cent in FDI, to obtain management
leverage over the joint venture company.

Rajinder Bhatia, defence vertical chief of
the Kalyani Group, cautions against giving FIIs too much space in the Indian
defence industry, since they are inherently short-term and speculative, unlike
FDI, which is a longer and more strategic investment.

Bhatia agrees a favourable business climate
will be the main driver of FDI. “Unless business flows due to its own
commercial logic, the new liberalisation measures are mere catalysts. You must
create business constituents to truly boost FDI”, he says.

Rahul Chaudhry, of Tata Power (Strategic
Engineering Division) who heads Ficci’s defence committee, cautions about the
need to carefully watch FII investments, which are inherently opaque. With 49
per cent FDI/ FII investments permitted under the automatic route, there will
be no examination of FDI proposals unless it is above 49 per cent.

“It is good that the government is
attempting to liberalise FDI. But it must be done while carefully protecting
indigenous defence capabilities”, says Chaudhary.

===================What industry says:

Ficci
chief, Jyotsna Suri

“Simplification of procedures for foreign
investments, putting more sectors on the automatic route, introducing
fungibility between FDI and FII and having a single reference document for all
FDI related guidelines are steps that would boost investor confidence further.”

Jayant
Patil, Larsen & Toubro defence chief

“Defence is a strategic field that is not
governed by the rules of normal commerce. Raising FDI caps is no guarantee that
foreign investment will flow in. Overseas vendors might want to ‘Make in
India’, but their governments may not give sanction, since most governments
control defence technology”.

Rajinder
Bhatia, defence chief of Kalyani Group

“Unless business flows due to its own
commercial logic, the new liberalisation measures are mere catalysts. You must
create business constituents to truly boost FDI”.

Rahul
Chaudhary, Chairman, Ficci Defence Committee

“It is good that the government is attempting
to liberalise FDI. But it must be done while carefully protecting indigenous
defence capabilities”.